The hedge fund industry has gone through significant changes over the last 20 years with a recent paper providing a good description of how hedge fund structures have adapted especially since the GFC. See from Clear Alpha Technologies "The Evolution of Alpha: Exploring the past, present, and future of investing in alpha". I don't like the title because this is not about alpha creation but how an industry has adapted to changing tastes by the market to deliver what is expected to be a better alternative investment product. The alpha creation from the bundling of strategies is different from how returns are delivered to investors which is the topic of this paper.
The hedge fund industry started with the development of specialized money management funds which usually had a focused objective. From traditional long-only managers came the broader focus of long/short managers. Unfortunately, there are many ways to generate return and alpha, so investor demand bundled products in the form of fund of funds. Unfortunately, many fund of funds did not delivery on the expected promise of higher returns and controlled risk.
Fees were higher relative to what was delivered so the market looked form other alternatives. One approach was to bring the investing in-house as market knowledge of hedge funds increased. The suppliers of returns developed in a different direction through creating multi-strat programs under a single structure. This was extremely successful, but there were limited in the ability of these multi-strats to gather the investment talent relative to demand. A new development was the multi-strategy, multi-manager fund which blended internal and external managers in a single structure. In both cases, the multi-strategy approach allowed for better risk oversight and more effective management of capital allocation.
The other development from the multi-strategy structure was the pass-through of costs. This pass-through model protected the hedge fund business and had the ability to provide a better cost structure to investors if the costs could be controlled. Investors were now investing in hedge fund businesses not giving money to be managers. There is a nuanced difference but has a significant impact on both the suppliers and demanders of alpha. The suppliers can invest in technology and risk management and reduce fluctuations in revenue. Investors, the demanders of hedge fund services, can form strategic partnerships but may have to pay a premium for the services of these multi-strat managers.
Hedge fund management is a very dynamic industry which will evolve as alpha changes, and the management structure will impact alpha.
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